MBS recap: originator selling and profit taking continues on strong performance this year

Despite the holiday-shortened trading week, with many participants away on vacation, the mortgage sector was fairly active. Originator selling and profit taking was relatively strong at about $3 billion to $4 billion dollars early in the week as Treasuries traded lower. The resulting spread weakness, however, attracted buyers particularly from servicers, CMO dealers, banks and money managers. As a result, spreads were just one basis point wider on the week for current and cusp coupons.

The strong performance within the mortgage sector so far this year, is encouraging ongoing profit taking from accounts. According to JPMorgan's bi-weekly MBS Client Survey, the share of overweights fell to 38.6% from 45.8% in the previous report. At the same time, the share of neutrals increased to 50.0% from 43.8%. Several firms on the Street also have either reduced their overweight positions or moved to neutral at this time. The outlook, however, is still supportive for the sector with high paydowns continuing the need for reinvestment, a range-bound market, declining issuance, strong CMO issuance, and declining vols.

Mortgage indexes remain strong

The Mortgage Bankers Association reported that its weekly Refi Index fell 10% to 1928 for the week ending February 15. At the same time, the Purchase Index declined 8% to 290. As a percentage of total applications, refinancings represented 51.5%, down from 53.1%. Salomon Smith Barney attributed the decline to the looming President's Day holiday. This week's number is predicted to be little changed after seasonal adjustment for the holiday as mortgage rates were lower.

Freddie Mac announced that mortgage rates for the week ending February 22 dipped further. The 30-year mortgage rate fell five basis points to 6.81%. This is the lowest level since mid-November when the 30-year was at 6.75%. The 15-year rate was down seven basis points to 6.28%, and the 1-year ARM rate came in at 4.96% versus 4.98% in the previous week.

Prepayment outlook

With rates holding lower, prepayments are expected to start trending higher in the March report. In comments, Bear Stearns says that they expect to see a pickup in prepayments that will bring speeds close to last October's levels for most cohorts. Looking to the next two reports, Bear predicts speeds in February to slow between 10% and 20% for most coupons and vintages. In March, they expect FNMA 6s through 2001 7s to jump 20-25% and other coupons and vintages to increase a modest 5%.

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